Hedging, the lifeline many oil companies scrambled for when oil prices turned south, has left some sidelined this year, dampening the sizzle on their second-quarter earnings. "I think [hedging] is the prudent thing, especially if a company has a lot of debt, but I think that we've seen some unfortunate instances where some people have gotten a little bit too smart for their own good and were a little asleep at the switch," says Brad Davis of Southwest Securities in Houston. "With the whole variety of financially engineered hedging products out there, they kind of got bitten a little bit." The range of volumes under hedging contracts goes from nothing for Anadarko Petroleum Corp., which has a fairly strict no-hedging policy, and Unocal Corp., to 61% of production for Louis Dreyfus Natural Gas and 70% for The Houston Exploration Co., according to Donaldson, Lufkin & Jenrette. "Most of the independents in our coverage universe could feel stiff headwinds from hedging strategies in the second quarter," says DLJ analyst David C. Bradshaw. "Cash flow per share for the companies in DLJ's universe may be up as much as 116% from the same quarter in 1999 and 15% ahead of this year's first quarter. But on average, 35% of second-quarter equivalent production is under either a fixed contract or a collar arrangement and 31% of volumes are hedged for the third quarter." Sacrificed potential revenues due to hedging range from zero for Anadarko and Unocal to as much as 80% of expected cash flow for Nuevo Energy, whose production is about 80% oil, according to DLJ. Cross Timbers Oil Co. recently disclosed that while its second-quarter paper profit was $16.3 million, it took a $15.7-million after-tax loss in the fair value of certain derivatives because of hedging. Factoring in a $200,000 after-tax gain on investment in equity securities, the company's earnings ended up just $800,000. Belco Oil & Gas Corp. reported that "commodity-price risk-management activities" reduced its second-quarter revenue $44.7 million. The company recorded a net loss of 42 cents per basic common share. Without the hedging losses, net income would have been 15 cents per share. Given the severe price crash of 1998, "it's not surprising that those who didn't have hedges slapped some hedges on as soon as they had the first breathing period. Or, if they were in gas and were already suffering in oil, thought they might as well protect the other side of the cash flow stream, and that was the gas side," says Stephen Smith of Dain Rauscher Wessels in Houston. The good news is that many analysts are quite bullish about commodity prices through the rest of this year, so companies with expiring hedges will be able to maximize their earnings soon enough. For example, DLJ says The Meridian Resources Corp.'s hedging contracts expired in their entirety at the end of the second quarter. "I think in the fourth quarter most of the companies we look at are largely unhedged," says analyst Greg McMichael of A.G. Edwards & Sons in Denver. -Jodi Wetuski and Leslie Haines

Comments